By Jean-Nicolas Caprasse – Managing Partner and Julia Wittenberg – Principal at CamberView Partners Europe
The post-financial crisis era has seen the emergence of institutional investors taking a more active ownership role vis-à-vis their portfolio companies and assuming a more engaged risk oversight function as they discharge their fiduciary obligations.
Against a background of increasing pressure on investors to behave as ‘responsible owners’, shareholders have become more assertive in their communications and interactions with executives and non-executive board members of their portfolio companies, an evolution that remains in full swing across capital markets.
Increased fiduciary responsibility of institutional investors
In Europe, the increased debate about corporate governance and the responsibility of institutional investors to oversee non-financial risk factors has led to the creation of stewardship codes or guiding principles in several markets, including the UK, the Netherlands, Switzerland and Italy. The Principles for Responsible Investment (PRI) – the international initiative seeking investor commitment to a proper understanding of investment implications of environmental, social and governance issues and the integration of these issues into investment and ownership decisions – has also gained considerable visibility. It now has nearly 1,400 members and a combined $59trillion of assets under management.
The list of various initiatives in this space has proliferated, both at national and international levels and at political and NGO levels. The ongoing debate around sustainability and climate change, only enhanced by the recent climate agreement decided on at the 2015 Paris Climate Conference (COP21), is pushing investors to take a more active role in understanding how their investee companies are managing environmental and social risk factors and how their businesses are responding to increasing regulation in this field.
“Demands on investors to act as responsible, long-term owners have increasingly led to engagement activities between investors and listed companies that seek to hold management accountable”
As asset managers acting on behalf of underlying clients are increasingly exercising their stewardship responsibilities and overseeing risk areas that have historically been left unattended, it is becoming vital that companies structure a successful shareholder engagement programme. Whereas in the past investors would sell out of their investments when faced with an underperforming investment or unresponsive management team, demands on investors to act as responsible, long-term owners have increasingly led to engagement activities between investors and listed companies.
Investors increasingly are seeking to hold management accountable in areas including operational performance, strategy execution, executive pay, as well as board oversight and environmental management. The emergence of these new and influential investors, including passive asset managers and activists, has added an extra layer of complexity to the widening array of topics in which investors are seeking to engage with company managers and board members alike.
Foreign ownership on the rise in Europe
In Europe, foreign ownership of EU-listed companies (including ownership by investors based in EU countries other than the country of domicile) has been trending upward for the past three decades, while the share of European investors in cross-border investments has been declining. The emergence of large US and UK institutional investors and the gradual dismantling of traditional ownership structures dominated by bank and insurance companies on the share registers of many continental European companies has led to an increase in their free float, thereby increasing companies’ needs to stay focussed on their investors’ needs. The 2008 EU Shareholder Rights Directive further smoothed out the voting mechanics across many European markets through the introduction of record dates and the removal of traditional blocking of shares prior to shareholder meetings, leading to an increase in quorum.
In addition, the upcoming Draft Shareholder Rights Directive is likely to further push European investors to increase their vote participation by reinforcing their fiduciary duty to vote and engage with investee companies.
One of the most significant developments in the investor landscape has been the emergence of index-tracking investment funds. Statistics indicate that actively managed funds are underperforming index funds over time while charging higher fees than their passive counterparts. Passive powerhouses Vanguard, BlackRock and Legal & General are among the investors who have amassed considerable assets under management at a global level. According to the Wall Street Journal, in the US, Vanguard’s nearly $470billion Total Stock Market Index Fund is now nearing the AUM of the four largest active funds in the US combined.
Index-traded funds, by their very definition, are long-term investors, with little manoeuvring room to sell out of their investment. To influence a company’s management over time, these asset managers have set up governance and stewardship teams responsible for exercising ownership responsibilities both through voting rights and engagement with management and boards. Combined with their considerable holdings size, their more active role means that index investors have the ability to significantly influence outcomes at both routine and contested shareholder meetings. This has brought about an increase in investor-led activism in areas such as executive pay, board composition and diversity and other governance topics.
On the opposite side of the spectrum is the rising presence of activist investors. Activist hedge funds in particular – many of which are event-driven and of US origin – have been targeting European companies. They aim at unlocking shareholder value through governance improvements, refocussing strategy or changing capital allocation policy. Recent figures indicate a rise in the number of European activist fund launches as well, such as Active Ownership Capital in Germany that led to the ousting of the chairman of the supervisory board of a pharmaceutical company in August. Activist tactics largely remain the same regardless of nationality, but activists have become increasingly adept at using sophisticated techniques to adjust to local market mechanics and legislation. A prominent example is Elliott Advisors, the London-based international arm of New York-based activist hedge fund Elliott Management, which has built up stakes in acquisition targets across Europe, extracting higher bid premiums by leveraging local merger regulation.
While activist investors vary by strategy and investment horizon, they often look to influence companies directly by seeking board representation. Specialist research demonstrates that the number of European proxy fights has remained persistent at around 20 per year, but the size of the target companies has increased in market cap over time, peaking at a median of €231million in 2016, mirroring the trend in the US where activists have not shied away from targeting Fortune 100 companies in recent years. According to the specialist publication Activist Insight, in Europe the total number of companies publicly targeted has increased from 51 in 2014 to 67 in 2015 and a surprising surge to 64 for the first half of 2016.1
An activist will often use governance shortcomings and operational weaknesses to obtain support from other institutional investors in a proxy contest or activism situation. It is worth noting that large institutional investors’ willingness to side with activist managers, particularly when their own engagements have failed to produce the desired results, is often the tipping point in an activism situation. At the same time, in the US, there has been a significant rise in settlement of proxy contests prior to reaching a shareholder vote. The debate is now shifting, with various long-term investors, including BlackRock and State Street, issuing warnings to corporate boards not to settle with activists too rapidly in order to preserve long-term value creation.
How companies can develop an engagement programme with their investors
In this context it is paramount for companies to have a proper understanding of their investor base, as well as any substantial shifts in the type and size of shareholdings over time. Companies with a secondary listing in the US may already be in the habit of regularly verifying whether their shareholder base is composed of less than 50 per cent of US shareholders in order to be eligible for exemptions under the Foreign Private Issuer status. But most European companies will benefit from regularly conducting a shareholder identification programme in order to gain insights into the shifting investment priorities of their institutional investors.
Understanding the relevant investor teams charged with the voting and engagement process and knowing where responsibilities lie within the teams themselves are equally important factors to consider when structuring an effective engagement programme. Companies often make the error of leaving important discussions with vote decision makers until shortly before the shareholder meeting, rather than building relationships with key investors throughout the year. The internal set-up of the vote decision-making process will vary depending on the investor, so it is critical that companies understand the specific decision-making process of each shareholder. In some instances it will require companies hold separate discussions with both the investment and governance teams and also manage situations where the two investor teams do not necessarily communicate with each other.
“In the last two decades, corporate scandals and ensuing legislative, regulatory and market developments in Europe, pushed investors into taking a more active ownership role”
Understanding the various stakeholders that provide input into the vote decision-making process will ensure that companies are thoroughly preparing their shareholder engagement strategy. Globally, leading proxy advisors Institutional Shareholder Services (ISS) and GlassLewis, in addition to various local players, issue research reports and advise their investor clients on how to vote at the shareholder meetings of the companies in which they invest. The extent to which investors follow these recommendations varies by investor, market and topic. Though it can be helpful for companies to engage with proxy advisors directly, it is necessary to understand the role these companies play in investors’ internal decision-making process. Specialist data providers, such as MSCI-ESG or Sustainalytics, sell-side research reports and the financial press more generally are among the various other sources that supplement investors’ in-house research processes. Keeping in mind that the primary source of information that investors use remains publicly available company disclosures, it is crucial that issuers are thoughtful in their messaging to their investors.
Accompanying public disclosure and messaging concerns is the comply-or-explain environment that applies to corporate governance frameworks in most European markets. With dissent rates at European shareholder meetings on the rise, investors are demonstrating impatience with companies that have historically entrenched management who fail to address actual or perceived oversight shortcomings, or who fail to deliver financial results for investors over time. A case in point is the executive pay debate, where votes cast against remuneration proposals have been steadily increasing and political pressure on investors has added another layer of complexity to the discussion.
Companies will benefit from driving the meeting agenda and proactively addressing matters of interest with their shareholders (strategy execution, management incentives and sustainability, to name a few). Investors meet with hundreds of company representatives every year, so being direct and following up will demonstrate accountability, as will bringing the in-house subject matter expert and, in some cases, a board member to investor meetings. In the last two decades, corporate scandals and ensuing legislative, regulatory and market developments in Europe, have pushed investors into taking a more active ownership role. During the same time, the investor landscape has evolved in Europe with the emergence of a variety of institutional investors, an internationalisation of the shareholder base and the undoing of traditional ownership structures.
Building a shareholder engagement programme and maintaining an active dialogue with investors and their relevant teams benefits companies in the long-term, especially when facing an important vote, corporate action or sensitive governance questions. To succeed with shareholders, companies must take ownership of the engagement process and remain on their front foot with their investors.
About the Authors:
As Managing Partner, Europe, Jean-Nicolas Caprasse leads CamberView’s European practice. Jean-Nicolas brings over 20 years of experience in corporate governance to CamberView’s European clients. From 2005 to 2016, he served as European business head for ISS, the leading global proxy advisor. Jean-Nicolas joined ISS through its 2005 acquisition of Deminor Rating, of which he had been a co-founder and the Managing Partner since 2000, and a partner of Deminor International since 1993. Prior to joining Deminor, he spent five years with JPMorgan as a Capital Markets Associate in Brussels and New York. He started his business career as an assistant to the CFO at American Petrofina (now Total SA) in Dallas, Texas.
Jean-Nicolas holds a degree in Business Engineering from Solvay Business School of Management (ULB/VUB) in Brussels and an MBA from INSEAD in Fontainebleau, France. He has been a member of Belgium’s Corporate Governance Commission from 2010 until 2016 and is a Laureate of the Prince Albert Fund (now King Albert II of Belgium).
Julia Wittenburg joined CamberView in February 2015 with more than 12 years of experience advising on and shaping governance and responsible investment frameworks for institutional investors and corporations in both Europe and the US.
Prior to joining CamberView, she was responsible for proxy voting and engagement for key European markets at BlackRock Investment Management in London. She started her career in corporate governance as an international research manager for Institutional Shareholder Services (ISS) in Rockville, MD and has advised corporate issuers on governance matters in various capacities in both New York and London. She serves as faculty member for the Conference Board Governance Academy.
Julia holds an M.A. in International Economics from the University of Kentucky and a B.A. from the University of Strasbourg, France. She is fluent in English, German, French and Portuguese.
1 Activist Investing in Europe: A Special Report, Activist Insight, September 2016